Converting an LLC to a C-Corp: Things to Consider

Have questions about converting your LLC to a C-Corp, we've got you covered!

When we get asked about things to consider when thinking about converting from an LLC to C-Corp, these are the most common reasons to convert that we see:

  1. Founders are able to benefit from QSBS treatment (Rule 1202) for their own equity (must hold for 5 years, only applicable to C-Corp qualified small businesses).
  2. Granting equity to team members is much easier in a C-Corp (no K-1s, no profits interests, option grants are typically very straightforward and can get ISO treatment, etc.).
  3. VCs will typically require you to be a C-Corp prior to their investment.

Obviously there can also be drawbacks that you should consider, primarily the following:

  1. Inability to pass through net operating loss (NOLs) to founders to offset other tax liabilities in a C-Corp.
  2. Entity-level taxation at a C-Corp (often called "double taxation").
  3. Potential tax implications upon conversion or even down the road at acquisition. Primarily if debt in your company exceeds the FMV (adjusted basis) of your equity, then you may get hit with taxes. Debt can include convertible notes and founder loans, which often pop up in startups.
  4. Complicated cap tables (profits interests, etc.) make converting into a C-Corp very complicated and messy.

Here are some of our responses to these concerns:

  1. Not being able to pass through NOLs as a founder can hurt if you have other tax liabilities that they can be used to offset (passive income, spousal income, capital gains from investments, etc.). But if your only source of income is your startup, you may not have other tax liabilities. Additionally, the tax benefits that you could get from being able to take advantage of Rule 1202 (QSBS) could potentially outweigh any benefit you get from NOLs from your startup. Obviously, this is situational for every business and every founder, but it is something to consider.
  2. Double taxation shouldn't be a major concern with most startups and high growth companies, because you are growing and expensing all your revenue on your growing team, increasing S&M budget, getting founders' salaries up to something closer to their market rate (finally!), hiring more developers, etc. 
  3. Conversions usually aren't taxable events if done correctly (always consult your tax advisors when doing a conversion!), though as pointed out above, make sure you talk to your accountant if you have any debt.
  4. Even complicated cap tables can be converted into a properly ordered C-Corp conversion, it just takes a little more effort to make sure all outstanding equity and interests are converted into "economically equivalent" rights in the C-Corp.

Please remember, Savvi isn't a law firm and we don't claim to be tax advisors or experts. You should ALWAYS consult your tax advisors and attorneys before doing an entity conversion into a C-Corp, regardless of whether you use a Savvi workflow to do it or not.

Also, here are some good articles from outside of Savvi to look at that may help explain some of the tax implications: